How higher interest rates are confounding younger investors

City Voices (ES)
City Voices (ES)

It’s hard to imagine that just under two years ago the Bank of England's base rate stood at an all-time low of 0.1%. Today, it stands at 5.25%. The last time rates were this high was back in April 2008, before the financial crash, and at its highest in 1981 when rates reached 15%.

It remains unclear if rates will continue to rise. On the one hand the BoE will want to keep inflation in check, which is still some way off its 2% target, but on the other hand there is pressure to keep rates low to boost financial markets and reduce the cost of living.

Regardless of what decision the BoE takes next, the speed at which rates have risen has posed a challenge to prevailing investment attitudes, especially for a generation of people who have never lived through a high interest rate world.

Prior to December 2022, people in the UK between the ages of 18-40 were actively participating in the equity markets, at home, online more so than those over 40. A nationwide OnePoll survey carried out before the BoE embarked on its rate hiking cycle (August 2021) revealed that more than half (57%) of Gen Z and 48% ofmillennials in the UK were trading or investing in stocks online.  By contrast, just 35% of 41–56-year-olds (Gen X) and 28% of Baby Boomers (57-75 year olds) said they had dabbled with stocks and shares online.

But the rise of the young, autonomous stock market enthusiast seems to have hit a wall. A recent report by Charles Schwab UK, highlighted a 19% drop in the number of millennials who said they found it easy to make investing decisions in the current climate and 73% of Gen Z investors are unsure how to adapt their investment strategies to protect against losses in the current financial climate.

The rapid rise in interest rates, lower stock prices and a higher cost-of-living seems to be impacting confidence disproportionately across generations. But why? The proliferation of online trading and investing platforms, 24-hour news cycles and the birth of investor tribes via community platforms like Reddit, have largely influencedtrading behaviour among younger cohorts in the recent decade.

For this community of traders, ‘growth’ stocks rule supreme and none more so than the “magnificent seven” tech stocks—Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla. But higher interest rates have made the future cash flows of these companies potentially less desirable, which is reflected in their lower stock price and weaker earnings.

Growth stocks are usually more volatile, meaning they offer better returns in times of growth, but they are usually heavily punished in times of uncertainty because their cash flows are deemed to be irregular, or they are too sensitive to the economic cycle. Value stocks will likely weather the storm better than growth stocks and small-cap companies. Value stocks usually belong to sectors that are more inelastic where their consumption will not vary much with price, like consumer staples.

Having the confidence to stray from the herd and diversify away from popular growth stocks to include value or defensive stocks, poses a challenge for a group of people who have only ever traded popular, high-growth names like Tesla and Apple against a high interest rate environment.

Essentially it comes down to knowledge and experience. People generally want to do the sensible thing with their money but haven't been in the markets for long enough to understand how to benefit from changing investment environments or lack the technical know-how. For the vast majority of investors and traders under the age 40, and who aren’t professionally involved in financial markets, this is the first time they have had to contend with a markedly different equity market brought on by higher interest rates.

In a world where younger people have been locked out of the property market, learnt to invest for themselves and gravitated to equity markets to make up for a 15-year period of near zero interest rates, it's perhaps unsurprising they may struggle to adjust to a new world order.  It will be interesting to see if habits change shouldinterest rates continue to rise and stay high for longer, but even then, can we really expect a generation of people to switch up their investment habits without any guardrails? How the wider industry supports this group of investors with education and learning tailored to their needs and behaviour, will be key to their future success.

Kypros Zoumidou is Group CEO at retail trading platform,